Proof of Work & Proof of Stake

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Proof of Work & Proof of Stake

How Bitcoin is Secured


TL;DR:

  • Instead of relying on third parties to transact, the bitcoin network uses a consensus mechanism called Proof of Work. While there are alternative security models to PoW, bitcoin's history proves PoW can effectively and efficiently secure a network.
  • In PoW computers compete to solve complex math problems first. Completing it first allows them to add a block of bitcoin transactions to bitcoin's ledger, the blockchain.
  • In return, miners (people running the computers) earn bitcoin and the bitcoin network is secured.

Traditionally, people are dependent on third parties to transact. Banks usually serve as the intermediaries, holding and securing money for some while giving others a chance to borrow capital.

While this model works most of the time, it can infrequently have devastating consequences, like in the 2007-08 Housing Crisis. After 2008, one person or group of people decided to build a system reliant on verification instead of trust.

That system is bitcoin and the creator, Satoshi Nakamoto, having seen the dangers of trust reliant system created bitcoin to have, among its many notable features, a novel design that enables security through decentralized verification and teamwork.


Proof of Work:

Bitcoin uses Proof of Work (PoW), a consensus mechanism that:

  1. Requires bitcoin miners to use energy to confirm transactions. This disincentivizes wasteful blocks and lets consensus be driven by verification, not trust.
  2. Determines coin issuance (every block of transactions sends 6.25 new coins to the miner, about every ten minutes).
  3. Provides network security by making security a function of the money miners spend competing for new coins.

Terminology: Bitcoin miners - mine for bitcoin much like old-timey miners panhandled for gold. But instead of using axes and pans, today’s miners use computers called nodes. For more bitcoin terminology see the Lolli Glossary.



These nodes compete to be the first computer to finalize a block of transactions. The block, once completed, is verified by the other miners then added to the blockchain, the open-source ledger containing every bitcoin transaction ever.

To finalize a block, miners must prove they expounded a certain amount of computational power solving complex math problems – the other miners check the validity of the math, which is easy to verify.

In other words, completing a block of transactions is expensive but checking it is cheap. The collection of nodes (computers on the bitcoin network) can easily reject false blocks and accept good ones, whereas nodes that create bad blocks waste their resources.

So, bitcoin is protected against bad transactions! But it’s even better than that. Because miners want the coins (and fees) issued with each block, they constantly are beefing up their mining power, making bitcoin even more secure.

Now, you may be wondering what happens if the majority of miners turn against the network and try to steal coins or double spend?

Well, that problem, called the 51% attack is prohibitively costly, not to mention unlikely to be successful. There are now so many nodes and so much power behind bitcoin that doing any sort of sustained attack on bitcoin would likely be more expensive than any gain. Not to mention attackers would probably make more by joining the network, mining bitcoin, and making the network more secure!

Lastly, miners could likely observe any group that was getting to close to the 51% threshold level, causing them to fork (or separate) networks from the hostile nodes prior to an attack. By incentivizing miners to confirm transactions by expending energy, the cost of issuing bitcoin is transformed into network security.


Proof of Stake

One alternative to PoW consensus is Proof of Stake or PoS. Some alternative cryptocurrencies or altcoins use PoS. In PoS, instead of being rewarded coins for greater processing power, people have a higher chance of receiving new coins if they have a greater stake in the network.

That means miners on this alternative network have a greater probability of receiving new coins if they have a greater share of coins on the network. In theory, this protects the network much like PoW. Miners who hold coins wouldn’t defraud the network because in so doing their stake in the network would lose value.

Instead of being solely a function of cost to mine, security is a function of how much the currency itself is worth. So, if the network is worth more than the network is more secure (in theory).

Advocates of PoS tend to be critical of PoW because of its high cost. However, bitcoin mining is a signal that the cost is worthwhile because people value bitcoin first; if people didn't demand bitcoin then miners wouldn't expend processing power to mine transactions. So, bitcoin really cannot be criticized for this feature. Costliness is not a defect but helps secure the network.

While PoS is an alternate to PoW, it is still experimental in many regards. As such, PoW, which has been used effectively by bitcoin for over a decade, meets bitcoin's security and consensus needs. Luckily, because bitcoin's code is open-source software, if any improvements of consensus mechanisms that are superior or improvements to PoS develop they could likely be implemented onto bitcoin.


Want more info? See The Essential Things to Know Before Getting Started With Bitcoin.

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The Lolli Team

Walt Smith

Walt Smith

Walt is a Research and Editorial intern at Lolli, a browser extension that lets you shop from 1,000+ brands online. He currently studies economics at Grove City College.

Newport Beach, CA